In In re Crumbs Bake Shop, Inc., No. 14-24287 (Bankr. D.N.J., Oct. 31, 2014), Judge Michael B. Kaplan of the U.S. Bankruptcy Court for the District of New Jersey held that trademark licenses may be entitled, under a bankruptcy court's equitable powers, to the protections of Section 365(n) of the United States Bankruptcy Code, 11 U.S.C. § 101 et seq. Section 365(n) provides that if a debtor-licensor rejects a license agreement for intellectual property, the licensee may elect to either terminate the license or retain certain of its rights under the license, including the right to continue to use the intellectual property. The bankruptcy court's decision is significant because it extends the Code's protections to trademark licenses even though trademarks are not explicitly included in the Code's definition of intellectual property.

Crumbs Bake Shop specialized in the sale of cupcakes and other baked goods and was a well-known brand. Crumbs entered into several licensing agreements with third parties, which allowed the parties to use the "Crumbs" trademark and trade secrets and to sell products under the Crumbs brand. On July 11, 2014, due to severe liquidity constraints, Crumbs filed for Chapter 11 bankruptcy protection. Shortly thereafter, Crumbs entered into an asset purchase agreement with a post-petition investor for the sale of substantially all of Crumbs' assets. The bankruptcy court approved auction-like sale procedures and, on August 27, 2014, entered a sale order approving the sale of substantially all of Crumbs' assets "free and clear of liens, claims, encumbrances, and interests" to the post-petition investor.

On August 28, 2014, Crumbs filed a motion to "reject" certain executory contracts and unexpired licenses, including the trademark license agreements. When a debtor rejects a contract, the rejection is considered a breach of that agreement as of the filing date. The rejection gives the "non-breaching" party the right to file an unsecured claim for any damages. See 11 U.S.C. Sections 365(g); 502(g). The licensees in this case, however, asserted that they should be able to retain their rights under their respective license agreements, pursuant to Section 365(n) of the Code. The post-petition investor, on the other hand, contended that trademarks are not included in the Code's definition of intellectual property, and that the licensees were therefore not entitled to the protections of Section 365(n).

The post-petition investor relied on the decision in Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043 (4th Cir. 1985), where the Fourth Circuit Court of Appeals held that a bankruptcy debtor's rejection of an intellectual property license deprived the licensee of the rights previously granted under the licensing agreement. The decision was widely criticized and, three years later, Congress responded by amending the Code to include Section 365(n). This subsection increases protections for intellectual property licensees by providing that, when a debtor-licensor rejects a license, the licensee can elect to treat the license as terminated or, in the alternative, can retain its rights under Section 365(n). If the licensee chooses to retain its rights, the licensee can continue to use the intellectual property. However, the licensor is not bound by any continuing obligations under Section 365(n), such as any requirement to provide continuing updates or maintenance to the licensee.

The Code, however, does not explicitly include trademarks in its definition of "intellectual property." See 11 U.S.C. § 101(35A). Some courts have inferred that the exclusion of trademarks from the definition indicates that Congress intended not to extend the protections of Section 365(n) to trademarks and, as such, the holding in Lubrizol was the governing law. Judge Kaplan disagreed with the post-petition investor and found the negative inference argument unpersuasive. Instead, he held that trademark licensees may be entitled to the protections of Section 365(n) on equitable grounds, citing the Senate committee report on the bill amending the Code. Agreeing with Judge Ambro's concurring opinion in In re Exide Technologies, 607 F.3d 957, 964-68 (3d Cir. 2010), Judge Kaplan found that Congress envisaged that the bankruptcy courts would use their discretion and their equitable powers to decide, on a case-by-case basis, whether trademark licensees could retain the rights listed under Section 365(n).

Judge Kaplan also disagreed with the investor's contention that if a licensee elected to continue using the trademark, a post-petition purchaser would have little ability to control the quality of products or services under the trademark. Market forces, — and non-bankruptcy law — the bankruptcy court reasoned, provide sufficient incentive to licensees to maintain a certain standard of quality in using the trademark. Judge Kaplan also noted that a bill to include trademarks in the definition of intellectual property had recently passed in the U.S. House of Representatives, suggesting that Congress was attempting to remedy the prejudice to trademark licensees under the Code.

The Crumbs decision also is significant for the bankruptcy court's holding that, absent the express or implied consent of the licensees, a sale under Section 363(f) of the Code does not trump a licensee's rights under Section 365(n). TheCrumbs court agreed that consent may be implied where a licensee does not object to a Section 363(f) sale, provided there is notice to that licensee. The court found, however, that the sale notice and the debtor's motion papers in question both failed to provide the licensees in Crumbs with adequate notice. The bankruptcy court commented that the "definitional maze" in the asset purchase agreement and the reference to the license agreements in a "mere ten words, buried within a single twenty-nine page" proposed sale order did not alert the licensees that an objection to the sale would be necessary in order for the licensees to retain their rights under Section 365(n). Accordingly, the licensees did not impliedly consent to the Section 363(f) sale and were therefore entitled to assert their rights under Section 365(n).

Lastly, the court ruled that the debtor-licensor, and not the post-petition investor/purchaser of the trademarks, was entitled to post-closing royalties under the license agreements. Judge Kaplan, citing In re CellNet Data Sys., Inc., 327 F.2d 242 (3d Cir. 2003), found that renewed royalties are directly linked to the licensing agreements rejected by the debtor, and not to the intellectual property which was sold. Therefore, in this case, the licensing agreements determined that the royalties flowed to the debtor.

Takeaway

The Crumbs decision furthers a recent trend in bankruptcy law and joins the Seventh Circuit Court of Appeals in extending, albeit on different grounds, Section 365(n) protection to trademark licensees. See Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372, 376–78 (equating rejection of a trademark license as a breach of contract). Moreover, Crumbs demonstrates the potential pitfalls arising from a failure to serve notice to licensees of intellectual property, which clearly indicates that a party wishing to preserve its rights under Section 365(n) must file an objection to the asset sale.